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Postscript
America Resurgent or
America Vulnerable?
We are not now that strength which in old days
Moved earth and heaven; that which we are, we are;
One equal temper of heroic hearts,
Made weak by time and fate, but strong in will.
—Alfred Lord Tennyson, Ulysses
Angst about the economic future of the United States has three causes. First,
in the aftermath of the recent global financial crisis, the fiscal and debt situation looks especially dire. Tax cuts, two wars, and the inexorable growth in
long-term entitlements, especially related to healthcare and the response to
the crisis, have combined to create serious doubts about the public-sector balance sheet. And if account is taken of the contingent liabilities that might be
accumulating because of the vulnerability of the financial system, the picture
looks grim.
The second and arguably more serious cause for concern is the country’s
structural problem arising from a combination of stagnating middle-class
incomes, rising inequality (particularly pronounced at the very top of the
income spectrum), declining mobility, and more recently, the apparently
declining prospects for even the college-educated. A beleaguered middle class
is emerging that, understandably, does not want to move down the skill spectrum but whose prospects of moving up through education and skill acquisition are increasingly affected by competition from India and China. There is
the serious risk that some of the cyclical problems from the recent crisis add
to, and become part of, the structural malaise. These include high levels of
unemployment, the rising number of long-term unemployed, and the rising
number of people who have dropped out of the labor force either directly or
by becoming claimants of disability benefits.
Lawrence Katz metaphorically captured the structural malaise. In an interview with Edward Luce of the Financial Times he said: “Think of the Ameri-
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can economy as a large apartment block. A century ago—even 30 years ago—it
was the object of envy. But in the last generation its character has changed.
The penthouses at the top keep getting larger and larger. The apartments in
the middle are feeling more and more squeezed and the basement has flooded.
To round it off, the elevator is no longer working. That broken elevator is what
gets people down the most.”1
The third concern relates to long-run growth. Countries at the economic
frontier tend to chug along at a certain “trend” rate of growth, which I have
assumed to be 2.5 percent for the United States and unaffected by the crisis.
That assumption might also be unwarranted. Carmen Reinhart and Kenneth Rogoff (2010) suggest a negative correlation between the high levels of
debt that the United States is approaching and growth (a correlation that is
strengthened if private levels of debt also remain high). Long-term unemployment, and the attendant skill attrition and loss of human capital, combined
with reductions in the labor force participation rate also exert a downward
impact on growth.
The United States, in short, has a fiscal problem, possibly a growth problem, and the most intractable of all, a distributional problem, relating to the
middle class. These can cumulatively lead to a downward spiral. But that is not
inevitable. Indeed, after 1993, thanks to some policy reform, but especially because of finding new sources of growth, the United States was able to address
its budgetary problems, turning deficits into large surpluses, and reversing,
albeit for a limited time, the previous trend of stagnating median incomes.
Indeed, one of the strong beliefs in the United States is that that episode
can be repeated, thereby heading off the threat to the nation’s preeminence
from a rising China. If the United States can fix its education problem and if it
can correct its looming fiscal deficits, the argument goes, then the fundamentals are there to ensure continuing economic dominance. These fundamentals
are captured in the 2009 survey by the Global Entrepreneurship Monitor,
which ranked the United States ahead of other countries in opportunities
for entrepreneurship “because it has a favorable business culture, the most
mature venture capital industry, close relations between universities and industry, and an open immigration policy” (as quoted in Nye 2010). Supporting
this is the fact that nearly all the major commercially successful companies
that have embodied breakthroughs in technology continue to be US-based
and founded, like Microsoft, Google, Apple, and Facebook. Moreover, the
culture of innovation and entrepreneurship are conducive to America playing
a crucial role in building and sustaining the global networks that are sources
of power in today’s fractured world (Slaughter 2009).
But confidence in America’s strengths, even if warranted, conflates the
absolute with the relative. Imagine a best-case scenario where the United
States bounces back from the recent recession, rediscovers new sources of
growth (say, in green and information technologies), reverses the trend stag1. Edward Luce, “The Crisis of Middle-Class America,” Financial Times, July 30, 2010.
190 eclipse: living in the shadow of china’s economic dominance
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Figure P.1 Economic dominance in a scenario where America is
resurgent, projection to 2030
index
25
US
20
US
China
UK
China
15
10
US
US
Germany
Germany
Japan
Japan
Russia
5
0
US
China
France
1870
1950
India
Japan
UK
1973
2010
2020
2030
Notes: This index is a weighted average of the share of a country in world GDP, trade, and world net exports of
capital. The weights are 0.6 for trade; 0.35 for GDP (split equally between GDP measured at market and purchasing power parity exchange rates, respectively); and 0.05 for net exports of capital. The United States and China
are projected to grow at 3.5 percent and 5.9 percent (in purchasing power parity dollars) per year, respectively,
between 2010 and 2030. All other countries are assumed to grow as in the convergence scenario described in
chapter 4.
Source: Author’s calculations.
nation of median household incomes, restores mobility and the prospects of
attaining the American dream, and overcomes domestic political bickering
to address its long-term fiscal challenges, thereby also reducing its long-run
foreign indebtedness.
Let us put some numbers on these optimistic developments and see what
the consequences for economic dominance might be. Suppose US growth were
to average 3.5 percent over the next two decades (which would be very high by
historical standards and match growth during the booming 1990s) instead of
the 2.5 percent currently projected. Suppose too that the US current account
deficit were to be considerably reduced as a result of bold fiscal actions.
What difference would these numbers make to the economic dominance
numbers depicted in figure P.1. The answer is that while the magnitude of differential between China and the United States changes a little, the picture of
Chinese dominance remains broadly unaltered.
Regardless of the disparity in dominance conveyed by the picture, could
an America that grows at 3.5 percent really be dominated by a China even if
it grows at 7 percent? The arithmetic difference between a growth rate of 3.5
versus 2.5 percent is not meaningful, but the practical difference might well
be. A 3.5 percent growth rate, by virtue of being significantly above the longamerica resurgent or america vulnerable? 191
© Peterson Institute for International Economics | www.piie.com
run trend, would embody a dynamism and engender an optimism that would
have a material effect on investor sentiment, confidence in the dollar as a
reserve currency, and in the US model more broadly. After all, it was through
strong growth that the United States saw off the threat from Japan in the early
1990s.
Indeed, the US-Japan dynamic of the early 1990s is helpful in understanding the US-China dynamic going forward. But it is the differences that stand
out. The first, and most obvious, difference is that Japan, unlike China, never
had the size to rival the United States. Perhaps an even more important point
relates to relative dynamism. Back in the 1990s, the United States surged while
Japan stagnated. Going forward, though, by virtue of being relatively poor,
China will, barring a collapse, have more dynamic potential than the United
States. To put it starkly, the US-Japan growth differential in the 1990s was
about 2 percent in favor of the United States. Even with the United States
growing at 3.5 percent, the differential will be 3.5 percent in China’s favor.
China might, in Alexander Gerschenkron’s famous characterization, reap the
advantages of “backwardness.”
Quite apart from the question of whether the United States can grow at
3.5 percent and for a sufficiently long period—remembering that even in the
1990s, the high growth momentum did not last more than a decade—there are
other crucial differences between the 1990s and the future. The United States
headed into the 1990s with considerably less government debt than it will in
the future: in 1990, the ratio of debt held by the public to GDP was about 42
percent while the latest projected figure for 2020 by the Congressional Budget
Office is close to 100 percent. The external position of the United States was
also less vulnerable then: for example, in 1990, foreign holdings of US government debt was 19 percent, today it is close to 50 percent.2 Moreover, in the
1990s it was considerably farther away from the date of entitlement reckoning
than it is now and will be over the next decade.
The most crucial difference might relate to America’s middle class problem. Over the last 20 years, the related pathologies that have come together
to create this problem may have become more entrenched, more intractable,
and less easy to solve. In that case, even the 3.5 percent growth rate may not be
adequate to preserve the attractions of, and confidence in, the United States
and the US model, which at its core is based on the hope of a better future not
for a few but for the many.
The dominance consequences can be checked under other scenarios.
Under the convergence scenario discussed in chapter 4, the differential was
4.5 percent (7 percent for China and 2.5 percent for the United States). With
America growing at 3.5 percent—the resurgent America scenario—the differential is narrowed to 3.5 percent. One should not rule out a growth collapse
in China, where the differential with the United States is narrowed, say, to
2. David Walker, “Comeback America: The Nation’s Fiscal Challenge and a Way Forward,” Comeback America Initiative, available at http://tcaii.org.
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Figure P.2 Economic dominance in a scenario where Chinese growth
collapses, projection to 2030
index
25
US
20
US
UK
15
10
US
China
France
US
US
Germany
Germany
Japan
Japan
Russia
5
0
China
China
India
Japan
UK
1870
1950
1973
2010
2020
2030
Note: This figure is identical to figure P.1 except that the United States and China are projected to grow at 2.5 and
4.9 percent (in purchasing power parity dollars) per year, respectively, between 2010 and 2030.
Source: Author’s calculations.
2 percent a year; nor should one rule out, however, a China that manages to
sustain reasonable momentum in its growth, in which case the differential
with the United States is 5.5 percent.
These latter two scenarios are depicted in figures P.2 and P.3, respectively.
Not surprisingly, even under a growth-collapse scenario, China maintains its
dominance, although less so than under the convergence scenario. And in a
resurgent China scenario, its dominance by 2030 starts to look similar to the
United States not in 1973 but in 1950.
These scenarios cast some doubt on the central American belief that
US economic preeminence is America’s to lose, that is, that American preeminence can be maintained if the country undertakes the necessary policy
corrections. In a world where relative performance matters for dominance,
whether the differential in growth between the United States and China will
be 2 percent (if China’s growth collapses) or 5.5 percent (in a resurgent China
scenario) will be largely—not exclusively—China’s to determine, depending on
its decisions and actions. In contrast, the range of possibilities for the United
States is much narrower. It is unlikely to grow significantly slower than 2 to
2.5 percent, even if crises lower those numbers for shorter periods. And it is
extremely unlikely to grow faster than 3.5 percent. This narrower range of possibilities is in some ways the “curse” of being at the economic frontier—both
the downside and certainly the upside potential are limited. China’s range of
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Figure P.3 Economic dominance in a scenario where China is resurgent,
projection to 2030
index
25
US
China
20
US
China
UK
15
10
US
China
France
US
Germany
Japan
Japan
Russia
5
0
US
Germany
1870
1950
India
Japan
UK
1973
2010
2020
2030
Note: This figure is identical to figure P.1 except that the United States and China are projected to grow at 2.5 and
6.9 percent (in purchasing power parity dollars) per year, respectively, between 2010 and 2030.
Source: Author’s calculations.
possibilities—which are up to China to exploit or forgo—are much greater. It
is this contrast that implies that China’s future dominance is more China’s to
gain than America’s to lose.
A final point relates to an inherent asymmetry in the relative possibilities and performance that strengthen the case for Chinese dominance and
for attenuated American control over affecting outcomes. The asymmetry is
that when the pace of technology creation by the frontier countries is slow or
limited, convergence in the poorer countries is largely unaffected because the
existing stock of technology is already available for all to use. But if the pace
of technological progress quickens in rich countries, new technologies can become quickly usable in countries such as China and India, providing a fillip to
growth in these poorer countries as well. In this case, faster growth in the rich
countries need not necessarily translate into faster growth relative to countries
such as China and India.
In a “flattened” world of convergence, the location of technological progress thus begins to matter less. In fact, convergence is happening precisely
because the “technology” of progress is becoming more replicable worldwide.
Dissemination more quickly follows discovery. And this is true in both senses
of “technology.” Information technologies, for example, drive innovation and
production in a physical sense. But they also globalize ideas and knowledge,
including how best to run an economy—the mistakes to avoid, the examples to
emulate, and the learning-by-doing-and-erring to attempt.
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As long as a country has the human capital skills to use, even if it cannot produce new technologies, progress is likely. According to estimates by
the National Science Foundation (NSF), in 2006, the number of science and
engineering undergraduates in China (about 912,000) was nearly twice that
in the United States. Over time, this differential is only likely to grow. Even
adjusting for what are sizable quality differentials in the education being
provided, China seems well-positioned to develop and absorb technology.
For example, US peer-reviewed scientific publications, which were six times
Chinese publications in 2002, were merely two-and-half times in 2008 because
China had posted a 175 percent growth rate compared with 20 percent by the
United States.
In other words, if the United States grows at 3.5 percent, one might have
to bump up the growth projections for China as well because the technological progress underlying America’s acceleration is China’s to emulate and adopt
as well. Put starkly, the asymmetry is this: Rich countries can fall behind, but
their ability to stay ahead in growth terms is inherently limited by convergence
and by the nature of new technologies and the ability of countries such as
China to more quickly use them.
The United States cannot escape the inherent logic of demography and
convergence. A country such as China that is four times as populous as the
United States will be bigger in overall economic size once its standard of living
exceeds a quarter of that of the United States (which has already occurred). A
converging, growing China will ensure that the gap in overall size will only get
larger over time.
The baseline scenario of a dominant China can be altered materially by a
resurgent America (of course, aided by a faltering China). But the preconditions are demanding. Not just will the United States have to grow substantially faster than long-run trend but it must be seen as strong fiscally and,
above all, able to reverse the pall of economic and social stagnation that has
enveloped its middle class. Such an America will restore the American dream
domestically but will also be essential to take the lead and play a key role in
shaping and strengthening the multilateralism that was described in the previous chapter as the world’s best insurance against an unbenign China in the
future.
Suez Canal Revisited?
A resurgent America can be a strong and vibrant nation but not necessarily
one that can easily exercise power and dominance over a rising China. So the
possibility of more dire scenarios under which the United States is actually
dictated to must also be considered. This book began with one such scenario,
in which China used its economic dominance to attain noneconomic objectives reminiscent of the experience of the United Kingdom, which “lost” the
Suez Canal in part when the United States exercised its power against an economically enfeebled and indebted Britain. The fantasy scenario of the United
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States going to the IMF was inspired by the Suez episode of 1956. But are the
implicit comparisons appropriate and relevant? It is useful to examine how
some of the specific elements of the two events, one real, one imagined, did
and might play out.
First consider the incentives of the rising creditor country. In 1956, the
withholding of financing for the United Kingdom by the United States—
directly and indirectly via the IMF where the United States could muster a
majority against the United Kingdom—had no serious consequence for the
dollar and the US economy.
Today, the argument is that China’s threat to not buy US treasury bonds
or even to sell some of its existing stock is not credible because the consequence of China’s action would be the very outcome—dollar decline and
renminbi appreciation—that China has been steadfastly trying to prevent in
order to sustain a mercantilist growth strategy and avoid large capital losses
on the stock of foreign exchange reserves that it has acquired by running large
current account surpluses for over a decade.3 So remaining sanguine about the
consequences of China wielding the creditor’s weapon may be warranted by
current conditions: At a time of a depressed US economy, the Federal Reserve
might be only too happy to buy US treasuries dumped by China.
But the dynamic and credibility of wielding the financing weapon in the
future could be very different from today’s circumstances. Ten years on, it is
quite easy to see China being less wedded to a weak renminbi. Indeed, if China
proceeds on the path of renminbi internationalization it so clearly seems to
have embarked upon, its ability and stake in maintaining a weak currency will
be considerably weaker.
Moreover, in the case of the United Kingdom back in 1956, its financiers
were more dispersed and included the private sector. In the case of the United
States, China—and, crucially, the Chinese government—is the largest net supplier of capital to the United States, accounting for a large share of holdings of
US treasury bonds, both in stock terms and as a financier of the flow deficits
of the United States. Leverage over the United States is thus concentrated,
not dispersed, and concentrated in the hands of those who can wield power.
So when the current imperatives for a weak renminbi fade, China’s ability to
wield power will be considerable.
Second, consider the exchange rate policy of the indebted country. In
1956, Britain was desperately trying to maintain a fixed exchange rate peg
and needed financial resources to do so, resources which the United States
controlled. However, the United States today is not, and will not likely be in
the years ahead, wedded to dollar fixity. Downward movements in the dollar
are less of a problem, especially since the foreign liabilities of the United States
are denominated in dollars and not in foreign currency.
3. For example, a 30 percent revaluation of the renminbi against the dollar would lead to valuation losses for China of about half a trillion dollars, or 10 percent of its GDP.
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The United States in 2021 may have less to fear from a decline of the dollar, even a disorderly one but vulnerable it will be even if for slightly different
reasons. Its vulnerability will arise from the combination of its fiscal fragility
and the fact that it might be dependent on its potential rival to economic
superpower status—the government of China—to keep supplying the foreign
financing necessary to forestall that fragility.
So, the proximate vulnerabilities might be different: external in the case of
the United Kingdom in 1956 and fiscal-cum-external for the United States in
2021. But the deeper parallel is this: The United Kingdom was vulnerable not
just because it was a debtor but because its economy had weakened and another power had emerged. The United States is also weakening structurally, its
government has become a chronically large debtor, its growth prospects have
dulled, and critically, a credibly strong rival—that controls the finance spigots
and that might also issue the premier reserve currency—has emerged. While
not an adversary, this rival is not an ally either—unlike the United Kingdom
and the United States in 1956. And it is one that has yet to sufficiently reassure
the world about its internal politics and extraterritorial ambitions.
To clarify, the 2021 scenario described in the introduction is still a very
low probability one. But stranger things have happened, as the recent global financial crisis showed. As John Maynard Keynes said, “the inevitable never happens, it is the unexpected always.” And while the triggers may be very different
than in this “handover fantasy,” it is the economic fundamentals—which this
book has shown are clearly moving against the United States and in favor of
China—that create the vulnerability. That an economically dominant China
will wield considerable economic power and that the United States will be vulnerable cannot be wished away as beyond the realm of possibility. Indeed . . .
***********
. . . on that February morning in 2021, after signing the agreement with the
IMF, the president of the United States makes his way through the bracing
cold air toward the cavalcade of black Lincolns that will carry him and his
entourage back to the White House. As he steps into his limousine, the bells
of the National Cathedral erupt in somber splendor. Self-aware and historyhoned—not unlike his once-removed predecessor, Barack Obama—the president is reminded of the funeral procession of King Edward VII over a century
ago, as described by Barbara Tuchman in The Guns of August: “The muffled
tongue of Big Ben tolled nine by the clock as the cortege left the palace, but
on history’s clock it was sunset, and the sun of the old world was setting in a
dying blaze of splendor never to be seen again.”
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